Silver Linings in The Corona
Evaluating the consequences of the COVID-19 global pandemic on innovation.
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Many founders and investors are evaluating the consequences of the COVID-19 global pandemic on innovation. The truth is, while there are many people writing their prediction of how to prepare for the new startup landscape, we are still weeks away from knowing the secondary and tertiary effects of the novel coronavirus on our innovation-driven economy.
For this reason, I think it is important we assimilate the data that is available to us to demystify rumors, unveil unfounded truths, and make informative inferences to frame a positive light on what is an incredibly unfortunate situation. Below is my take on the top-down silver linings of the coronavirus on entrepreneurship:
To begin, Limited Partners (LPs) are paying particular attention to the virus and the effect it is having on the stock market. Venture will take a hit (more on this later) as LPs move quickly toward more liquid assets; however, this will not affect the next three years of funding for startups. Venture Capital (VC) Firms are sitting on more than $189B of dry powder!
They have to invest this money or return it to LPs, which we can all assume will not occur unless they want to forego their management fees. Firms have been returning to LPs at a faster rate than ever in recent years to raise new funds. Like a startup having to lower their burn rate, VC firms now have to invest at a lower cadence than they are accustomed. For VC firms, this will result in the positive part of the investment J-Curve being steeper and in turn, a higher ROI for LPs.
I am forecasting that in the next six weeks we will see VC Firms develop a new system to conduct due diligence for new introductions made to them. This month and a half will result in fewer investment transactions; however, over the long term, funds will continue to deploy capital — albeit at a more deliberate rate due to being unable to meet in person.
These turbulent times will clearly illustrate which fund managers truly have conviction in their thesis. Overall, this can weed out the weakest fund managers in venture.
It will be an interesting time in venture capital for general partners raising new funds. We were already seeing outsized funds struggling to raise larger funds due to poorer returns than expected, such as SoftBank and Andreesen Horowitz. The coronavirus has brought an opportunity for outsized funds, such as Sequoia who labeled the coronavirus the Black Swan of 2020, to reset valuations in the market and to de-risk investments at the earliest stages. Tech companies in 2019 raised almost four times the amount of capital that a company going public in 2012 raised.
The “hottest” startups were becoming reminiscent of the dot-com era — a time that increased investor risk due to over-subscribed rounds and ballooned valuations. Outsized funds want to once again show a higher IRR in the early stages of an investment lifecycle in light of it being more difficult to raise institutional capital. This is incredibly healthy for venture. AGAIN: founders do not have to worry about VC firms pulling back funding!
As for Micro and Nano VC firms, I hope you raised your newest fund because family offices and high net worth individuals will be looking to stabilize their portfolio during the next several years. The past eight years have been very kind to emerging managers of Micro VC firms; however, 2020 and beyond will be much more challenging. A number of Micro VC funds were already declining and the market is starting to see an over-saturation of “differentiated” theses.
The expectations for an emerging manager are much higher now than they were eight years ago. Considering all of this and that in-person meetings will be far fewer, relationships with LPs will have to be harvested over a longer period of time. Expect to spend significantly longer raising your first fund. The strongest emerging managers will arrive on the landscape with unprecedented exposure to the venture scene.
As for startups in general, there are plenty of reasons to be optimistic. Why? Well, keep in mind the following companies that were founded during our last global financial recession:
Q3 of 2008- Airbnb, Wealthfront, Betterment, Druva, Stack Overflow, GitHub, Expensify
Q4 of 2008- Groupon and Hootsuite
Q1 of 2009- Uber
One might ask, why is it that great startups are born in times of crisis? There are a few reasons. First, a good CEO will lead their startup through tumultuous times. Where most will find reasons to bail, a great leader will find reasons to persevere and ways to pivot their startup to thrive in an alternative environment.
To summarize, the COVID-19 Outbreak will flush out the over saturated market of ill-equipped startup founders and leave the strongest teams to receive capital. Whereas poorly educated investors were making ill-advised bets, they will now find an abundance of opportunity with knowledgeable entrepreneurs who know how to be capital efficient in an environment that requires them to do so.
Furthermore, experienced founders should be excited by the impending stalls to rise in capital costs that founders will face from launching a startup and halt the ever widening gap between Pre-Seed and Seed.
This means hiring top-tier talent, will be cost and time efficient. There will be more available talent than ever before as weaker corporations exit the market and in turn, C-Level Executives will be looking for their next gig. As I like to say, “Carpe Diem!”
The investor’s silver lining from the coronavirus is that we are about to enter a “smarter” era of entrepreneurship. Top-down, big players in venture are becoming more intelligent. Those with conviction will win, and win BIG! LPs will actually see larger returns on investment, albeit at a slower place. For an investor, you can invest into startups at a valuation more in tune with the current market.
As for founders, contrary to popular belief, there has never been a better time to raise capital.
This article was originally published by Joshua Schlisserman on medium.
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